I can remove him for cause and his management company stays. Sanity check?

Third pass through a 63 page operating agreement for a 6.8M mixed use JV. I'd be 2.1M of a 2.4M equity check, operator brings 300k plus the deal. 8.5% pref, 70/30, standard enough on the surface.

Two things I found last night that I can't unsee.

First, section 9.3 defines Cause as "fraud, willful misconduct, or gross negligence, in each case as finally determined by a court of competent jurisdiction after all appeals have been exhausted." So the removal right requires a final unappealable judgment. Practically that's four years and six figures of litigation, by which time the asset is gone. Gross negligence is also the only performance-adjacent trigger, and missing a budget by 40% isn't gross negligence, it's just bad.

Second, section 11.2 says the property management agreement and the construction management agreement with his affiliates "shall survive any removal or withdrawal of the Manager" and are terminable only for their own defaults, with a termination fee equal to twelve months of fees. On projected revenue that's about 78k of PM fees plus whatever's left of the 4% construction management on a 1.4M budget.

So even in the fantasy scenario where I win a fraud judgment against him in 2029, he keeps managing the building and gets paid to be removed.

There's also a buy-sell in 12.4 at "fair market value as determined by an appraiser selected by the Manager," which I've already flagged.

What I'm sending back tonight is a rewrite of 9.3 with mechanical triggers and a rewrite of 11.2 so the affiliate contracts terminate on 30 days notice with no fee upon a removal event. He'll push back on both, and the deal is decent, so I need to know which one I actually fight for if he'll only give me one. Counsel is reviewing separately, I want the practical read from people who've sat across from operators on this.

Answer

3luis_carrera Get yours

Fight for 11.2. Fix the affiliate contracts and 9.3 stops mattering nearly as much.

The reason: a removal right you can never exercise costs him nothing to give you and costs you nothing to lose. It's decoration in both directions. The affiliate contracts are cash flowing out of the building every month regardless of performance, and the survival clause converts them into an annuity he keeps even if the partnership blows up. That's the clause that's worth real money to him, which is exactly why he'll defend it and exactly why it's the one to take.

There's a second reason 11.2 is the better fight. If the management contracts terminate on notice with no fee, you have leverage without litigation. The month he misses reporting or blows the budget, you sit down and say the PM contract goes away unless X happens. You never have to prove gross negligence to anybody. Practical remedies beat theoretical ones.

I'd also push a middle version of 9.3 that he can say yes to without feeling accused of anything. Add failure to fund a required contribution after a 10 day cure, and a loan event of default, as separate removal events with no court finding required. Those are objectively verifiable from documents he already has to produce, and most operators will concede them because they read as "if I default I'm out" rather than "if you think I'm bad I'm out."

One more, on the buy-sell in 12.4. An appraiser selected unilaterally by the Manager is worse than the survival clause in a bad scenario. Three appraisers, each side picks one, the two pick the third, or you're negotiating your own exit price against his appraiser.

6 replies

-1devon_pierce Get yoursPRO5

I'm still building a list and I read this thread twice just to learn what to look for. The final unappealable judgment language is going in my notes as a red flag.

One question. If he wrote 9.3 and 11.2 that way himself, isn't that information about him? Or is that just what his lawyer's template says and he's never read page 41?

1tonyv88SO4CPRO6

@bramble it's usually the template, honestly. I've been on the management side of a dozen of these and the survival clause exists because a PM company that gets fired every time an equity partner gets nervous can't staff a building. That part isn't sinister.

The twelve month termination fee is a different animal. Standard third party PM contracts in my experience run 30 to 90 days notice without cause, no fee, sometimes 60. Twelve months of fees is a number somebody chose. Fathom, ask him what his company's standard third party contract says and then ask why this one's different. That's a hard question to answer badly.

1joe_delgado5AP4CPRO6

78k of PM fees plus a construction management fee he'd keep collecting on a 1.4M budget he's no longer supervising. That's the whole thing right there. Take 11.2 and let him keep his fancy removal clause.

1aaron_fitz10 Get yoursPRO6

This is the thread I needed after posting my own version of this question. @windlass's point about verifiable triggers is what I was missing. Failure to fund and loan default are facts, not judgments, and an operator can agree to them without conceding he's the kind of person who'd need removing.

Fathom, when you send it back, are you sending both rewrites at once or leading with 11.2? I'd send both. If you lead with the one you actually want he'll trade you the other one and think he won.

2dmitri_v6CapitalPRO6

Two things to check while you're in there, since you're already at 2.1M of a 2.4M check.

Whether a for-cause removal touches his unvested promote at all. If he keeps the full 30% after removal, you've hired a permanent passive partner in your upside. Some drafts reduce it to a percentage based on time elapsed, some extinguish it entirely for cause, and the difference is enormous at exit.

Also check whether the loan documents name him as the required key principal or guarantor. If the lender's approval is needed to replace the Manager, your removal right in 9.3 is subject to a consent you don't control, no matter how you rewrite the trigger. I've seen a clean removal provision made useless by a two line clause in the loan agreement. Whether the lender will pre-approve a substitute is worth asking now, in writing, and how any of this actually plays out depends on the governing state's LLC act, so let your counsel read the two documents side by side.